Global economic momentum improving, but don’t ignore disconnect between stocks and Doctor Copper

07 January 2014

Global economic momentum is improving and looks set to surprise on the upside in 2014. However, Doctor Copper should not be ignored. Copper has frequently been dubbed the metal “with a Ph.D. in economics” for its uncanny ability at forecasting the global economic cycle. When the global economy expands, industrial output increases and demand for copper pushes its price up. The converse happens when the global economy contracts.

The two charts below show the 5-year weekly copper price and the MSCI World (Stock) Index for the same period respectively.

copper

msciworld

As can be seen from the above charts, the copper price has experienced a moderate correction/consolidation in the past three years, but global stock prices have surged ahead in the past year.

The copper price has continued to faithfully reflect the state of the global economy, which has indeed experienced slowing momentum in the past three years after a very sharp bounce from the deep recession lows of early 2009.

There is thus a disconnect between current world stock prices and the copper price. As such, the two may converge. A trade to consider might therefore be to buy deep in the money put options on global stocks coupled with deep in the money call options on copper. One of them may expire worthless, but the other could yield considerable profits at the same time.

Looking ahead in 2014, the global economic momentum looks ready to improve and even surprise naysayers.

Global-Momentum-

The above chart, courtesy of the Bank Credit Analyst, shows that in 2013, business confidence in the major economies rose above the boom/bust line for the first time since 2011.

There has been an acceleration in G7 nominal import growth, and industrial production in China and Japan is improving, although production and exports in the smaller Asian economies remain lackluster so far.

U.S. Fed tapering will likely put a lid on economic activity and restrain exuberance.

Nonetheless, the upswing in global economic momentum appears to have legs and is likely to continue in 2014.

Global stock prices have anticipated this favourable state of affairs and have priced in much of 2014’s growth potential. Thus, while the global economy and job market look set to make good gains in 2014, the stock market should start to lag and allow the broader economy to play catch-up. Therefore a long copper/short equities paired trade might make sense.

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